Simultaneous equations

Suppose we have following simultaneous equations

The reduced form for these equations

+

+ + ……..(5)

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(p) = + +
(p) = + + +

Estimating Simultaneous Equations Models

+

+ + ……..(5)

= + + ……… (6)

These reduced forms generate two solutions for α1:

or =

The demand equation is now over-identified, meaning we have more than one ILS solution for the identified demand slope,

To circumvent this problem, we propose 2SLS estimation technique.

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Estimating Simultaneous Equations Models

• 2SLS Estimator
• Step 1:Estimate the reduced form (5) and (6) (first stage) using OLS and keep the fitted values.

= +

= +

- Step 2: Replace the endogenous regressers with fitted values, and fit the second-stage regressions using OLS.

= + + ……> is a 2SLS Estimator for .

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